Written by

Pralhad Burli

Published

January 25, 2013

Amid lingering global economic uncertainty, the upside for South Korea’s economy is limited, and growth is expected to be anemic.The government lowered its growth forecast for 2013 to 3 percent, citing lower job growth and elevated inflation as key challenges. While growth is likely to pick up during the second half of the year, the first quarter, is expected to experience lower growth. The government plans to frontload fiscal spending, ease housing regulation, and support investment in order to revive the economy. However, external weaknesses and high household indebtedness will likely weigh heavily on the country’s growth prospects.

In 2013, the Bank of Korea (BoK) plans to implement a monetary policy that will support the country’s economic recovery and promote financial stability. In July and October, the BoK lowered its interest rate in a bid to spur growth. Monetary easing led to record-low bank lending rates, leading to a loan-deposit spread of 2.6 percent in November. Meanwhile, consumer price inflation came in lower than expected and fell to a four-month low in December 2012. The consumer price index gained 1.4 percent in December, following a 1.6 percent increase in the previous month. The central bank expects that inflation will likely rise to nearly 2.5 percent in the coming months. However, lower-than-expected inflation could allow the central bank some flexibility in easing monetary policy.

Exports account for over half of South Korea’s GDP, and they will play a key role in determining the country’s growth trajectory. Fiscal cliff negotiations in the United States and a prolonged economic slowdown in Europe have resulted in a drag on overseas demand and export growth. If the US economy is able to avert decelerating growth induced by fiscal concerns, South Korea’s export sector stands to gain. Although South Korea’s concerns have eased slightly following the temporary extension on US fiscal cuts until February, the outlook is likely to remain clouded for the next few months. The Korea Institute for International Economic Policy has forecast that a failure to reach an agreement on the fiscal deficit negotiations in the US could result in a 0.3 percent decline in exports, which could potentially lower Korea’s GDP growth by 1.1 percentage points.

Another factor holding back South Korea’s economy is high household indebtedness and a low savings rate.

Meanwhile, Korea’s trade surplus shrank in December 2012 as exports fell at a faster rate than imports. The trade surplus came in at $2.0 billion, down from $4.5 billion in November and $3.8 billion in October 2012. Exports declined 5.5 percent compared to the previous year, and imports shrank 5.3 percent. Export volumes, which began an upward trend in October, fell for the first time in three months. However, annual trade exceeded $1 trillion in spite of external uncertainties. South Korea benefitted from increased exports to the Middle East, which rose 11.4 percent. Exports to 10 member countries of the Association of Southeast Asian Nations rose 10.4 percent over the previous year, but shipments to Europe contracted 11.4 percent. Petroleum products became the country’s largest export item, accounting for 10.3 percent of total exports. However, exports of ships and wireless telecommunication devices declined.

Another factor holding back South Korea’s economy is high household indebtedness and a low savings rate. At the end of September, Korea’s household debt had risen 5.6 percent over the previous year to $882 billion. Meanwhile, the average savings rate for Korean families hovered below 3 percent. In addition, deteriorating job market conditions adversely impact consumers’ disposable incomes and hold back spending.

An uptick in foreign direct investment (FDI), which suggests increased investor confidence, is the silver lining amid broad-based economic weakness. FDI investments rose 57.8 percent to $10.4 billion in 2012 boosted by investments from China, the Unites States, and Japan. Moreover, auto production coupled with increased demand for clothing due to unusually cold weather bolstered factory output. However, domestic consumption is unlikely to compensate for the persistent decline in external demand, and the economy will remain vulnerable to its external environment due to the country’s dependence on export-led growth.